Friday 5 June 2009
2 Franchising For You Ltd (F4U) markets a range of franchises which it makes available to its customers, the
franchisees. F4U supplies the franchisee with information of the mode of operation, detailed operation schedules and
back-up advice (by telephone, internet) and undertakes national advertising. Each franchisee must arrange for its own
premises, equipment and undertake local marketing.
F4U is considering the introduction of a Dance and Drama franchise which would have an expected life of six years.
From this project, the only income F4U will receive from franchisees comes from the initial franchise fee.
The following estimates have been made relating to the cash outflows and inflows for F4U in order that F4U can
evaluate the financial viability of the Dance and Drama franchise proposal:
1. Initial investment of $6m. This will include a substantial element relating to the ‘intellectual capital’ requirement
of the proposal.
2. Development/improvement costs of $1m per year at the end of each of years two and three.
3. 300 franchises will be sold each year at a fee of $20,000 per franchisee.
4. Variable costs, payable in full on the issue of each franchise, are estimated at $6,000 per franchise.
5. Directly attributable fixed costs of $0·6m per year in each of years one to six. No further fixed costs will be
payable by F4U after this period.
6. Corporation tax at the rate of 30%, payable in the year in which cash flow occurs. Tax allowances are not
available on the initial investment or development/improvement costs payable by F4U.
7. All cash flows are stated in current prices and with the exception of the initial investment will occur at the end
of each year.
8. The money cost of capital is 15·44%. Annual inflation during the period is estimated at 4%.
(a) Calculate the net present value (NPV) of the Dance and Drama franchise proposal and recommend whether
it should be undertaken by F4U. (6 marks)